The first Annual Budget of the Hong Kong Special Administrative Region's new Financial Secretary, Antony Leung, covering the 2002-03 fiscal year was a model of restraint.

Faced with pre-Budget calls from almost every conceivable direction to "do something" to fix Hong Kong's revenue and deficit problems, Mr Leung surprised everyone by deciding to make few changes.

Even the public release of two high-profile, official government reports calling for (a) much less spending from government and/or (b) more and higher taxes could not move him to take immediate drastic action to trim spending or the deficit.

As a result, there were virtually no increases in existing taxes, no introduction of new taxes and spending cuts were limited to a proposal to cut civil service salaries about mid-way through the 2002-03 fiscal year.

This had the entirely unexpected effect of making Mr Leung's first Budget -- he only took over as Financial Secretary in May last year -- extraordinarily popular, or at least well received by both the business sector and the public at large.

If there was one disaffected group it was probably the civil servants, who are now facing the first ever wage cut in modern times. But even this action was hedged about so much that it was difficult to see whether the full cut will eventuate.

The only other disaffected group may have been the professional "budget watchers," the accountants and economists and others, who thought the Financial Secretary should have done more to address the Budget imbalances.

Instead, the Budget documents suggest the Financial Secretary is content to reply on a predicted recovery in economic growth to balance the Budget over time, although he did leave open the options of spending cuts and new revenue sources.

He did announce that a new land departure tax would be introduced -- but not until the 2003-04 financial year, and at HK$18 a trip it would be implemented under the euphemistic title of a Boundary Facilities Improvement Tax.

Referring to the prospect of new taxes, some time in the future, Mr Leung did, however, say that "... the government has to consider other options for raising revenue or reducing expenditure to make the shortfall....".

The "shortfall" refers to the continuing Budget deficits that are anticipated over the next several years and that are evident in the medium range forecasts (the five years to 2006-07) contained in the 2002-03 Budget documents.

Outlining the problems facing him in designing a Budget in the midst of the SAR's second recession in five years he said he felt under pressure because he had to address both the difficulties brought by the economic downturn and the problem of the structural Budget deficit as well.

He said he aimed to put in place measures to revive the economy and improve employment prospects, identify new directions for economic development and work with the community to sustain prosperity. At the same time, he wanted to offer some relief measures to business and the community during a time of economic difficulty.

"I am fully aware that, due to the externally-orientated nature of the Hong Kong economy and our linked exchange rate system (to the US-dollar), keeping public finances sustainable is of paramount importance," he said.

"The economic crisis in Argentina and the social unrest this has triggered are the results of over-borrowing brought about by persistent fiscal deficits and price rigidity. To safeguard Hong Kong against any such crisis, we must implement effective measures to restore fiscal balance within a reasonable period of time."

Faced with an estimated Budget deficit of HK$66 billion for the 2001-02 fiscal year (extending from April 1, 2001 to March 31, 2002), the Financial Secretary forecast another Budget deficit of HK$45.2 billion for the 2002-03 fiscal year.

However, this projected cut in the overall Budget deficit in 2002-03 is dependent entirely on obtaining HK$15 billion in MTR Corporation privatisation receipts (postponed from 2001-02) and an increase in earnings on the fiscal reserves to HK$12.7 billion from virtually zero in 2001-02.

While the overall emphasis in the Budget speech was on spending restraint, there was little of this in the numbers themselves and, indeed, revenue concessions worth HK$6.4 billion were given away (and welcome by business and individuals.)

The proposal that stood out most in all of this was the plan to cut civil service wages by 4.75 per cent and, therefore, the overall civil service wages bill (which makes up the largest part -- two-thirds -- of the governments operational spending).

The pre-Budget emphasis was also on the need to perhaps raise new revenues, but again there was precious little on this in the 2002-03 Budget, although there were warnings that there might be more to come in future years.

At the core of the Financial Secretary's medium range plan to bring the Budget back to balance by 2006-07 (a balanced budget being a requirement under article 107 of the Basic Law) is future spending and better revenues stemming from a more rapid rate of economic growth.

However there was little in the Budget on the specifics of how the government intends to achieve future spending restraint (apart from the proposed civil service pay cuts).

Economic growth for 2002 is expected to be only 1 per cent but beyond that it is projected to pick up to 3.5 per cent a year through to 2006-07.

For this period (and excluding the 2002-03 year), real growth in spending is scheduled to be below the real growth in the economy at 1.5 per cent. The expectation is that this will see Hong Kong back to sustained growth and to a healthier Budget balance sheet.

Looking back over the past year, the Financial Secretary disclosed that the Hong Kong economy grew by only a real 0.1 per cent in 2001 (down from 10.5 per cent in 2000). Deflation continued to affect the economy (and government revenues) throughout the year, with GDP deflator down 0.5 per cent and the Composite Consumer Price Index falling by 1.6 per cent.

For 2002, he expects the economy (gross domestic product or GDP) to grow by 1 per cent in real term, but deflation will continue, with prices expected to fall another 1.5 per cent as measured by the GDP deflator. However, for the five years to 2006-07, Mr Leung expects average growth of 3 per cent and average inflation of 0.4 per cent.

Outlining his strategies for Hong Kong's development he said his plan was to capitalise on Hong Kong's strengths, develop high-value-added economic activities, particularly financial services, logistics, tourism and producer and professional services.

He said he intended to upgrade quality of Hong Kong's manpower, and increase number of talented individuals, by improving education and attracting outside talent.

He also wants to promote development of local community economy closely linked to daily life, including small traders and personal services, to help employment; and seek to excel by using quality, speed and creativity to produce and deliver services and products

Another objective, he said, was to enhance the flows of people, goods, capital, information and services to and from Mainland of China, and seize opportunities likely to come from China's accession to the World Trade Organisation (WTO).

Looking at the ongoing large deficit situation, the Financial Secretary set two key targets to be achieved by 2006-07 -- restoring balance in to the Budget (as required by the Basic Law) and reducing public expenditure to 20 per cent of GDP or below. This compares with a present level of 22 per cent of GDP.

To achieve these targets, he plans that the government should contain the growth of government expenditure to below that of the economy from 2003-04 to 2006-07 and possibly raise additional revenues. But, as explained earlier, there are no specifics.

Total expenditure for the 2002-03 year has been estimated at HK$259.8 billion, with revenue expected to amount to HK$214.6 billion. The expenditure estimate assumes the 4.75 per cent Civil Service pay cut from October 1, 2002, and a corresponding reduction in the salary-related portions of subvention to various organisations.

This total government expenditure is higher than the revised estimate of 2001-02 by 7.7 per cent in real terms (much higher than the 1 per cent forecast economic growth in real terms of 1 per cent for 2002), and by 6.2 per cent in money terms.

Mr Leung said the expenditure number included funds earmarked for all initiatives announced in the SAR Chief Executive, Tung Chee-hwa's Policy Addresses, including improving education and employment, investing in infrastructure and helping the disadvantaged.

He said a further HK$400 million would also be allocated for implementing a two-year Youth Work Experience and Training Scheme to provide on-the-job training for about 10,000 young people.

Looking to the medium term from 2003-04 to 2006-07, he said growth of government expenditure would be contained at below the trend growth of the economy, so as to contain public expenditure at 20 per cent of GDP or below. But again there were no specifics.

The Financial Secretary announced only two very modest revenue-raising measures for the 2002-03 year, the first being an increase in the duty on wine from 60 per cent to 80 per cent. The second was a cut in the duty-free tobacco allowance for local residents by 40 per cent to 60 cigarettes or 15 cigars or 75 grams of tobacco and duty-free still wine cut by 25 per cent to 750 millilitres, equivalent to the standard size of a bottle of wine.

From 2003-04 onwards, however, he proposed to introduce a land departure tax -- named the Boundary Facilities Improvement Tax -- and has initially set the proposed charge at HK$18 for every person crossing the border to Mainland China.

He did however note that further revenue-raising measures might need to be introduced to redress the fiscal deficits by 2006-07. He said the government would consider the recommendations of the Advisory Committee on New Broad-based Taxes and other views, which recommended a consumption (sales) tax for Hong Kong.

In terms of relief measures for local business and individuals, Mr Leung proposed a package of one-off relief measures costing HK$6.4 billion in total. These included reduced property rates, and lower sewage and effluent charges. They also included lower diesel fuel duties, waiving business registration for a year and freezing a large range of other fees and charges.

Where the new Financial Secretary has seemingly broken with past practice, is in four major changes to accepted Budget strategy:

First, he acknowledged the government was running a "counter-cyclical" spending programme, involving the maintenance of spending to help offset the economic downturn. Previous Financial Secretaries had denied this was possible because of the government's small economic role.

Second, he seems to have a more relaxed attitude to ongoing deficits and fewer qualms than his predecessors did in spending the fiscal reserves (or at least some part of them).

Third, he has de-linked the size and adequacy of the fiscal reserves from the money supply numbers, and tied them only to government spending, with reserves at 12 months of government spending now being seen as adequate protection.

Fourth, he has thrown out the concept of the government's role as "positive non-interventionism" and "minimum intervention, maximum support" for something called "a pro-market enabler."

These are all major breaks with the previous government stances on these issues.